Flat Capacity= Continuing Profits

A year ago, in the aftermath of USmajor airlines posting one of their best earnings performances in years in the 2010 third quarter, US Airways chairman and CEO Doug Parker asked a pertinent question: Would the industry “give into temptation” to raise capacity and loosen its grip on cost control?

Or would carriers, chastened by the 2008 financial crisis, retain the discipline that allowed them to return to the black last year despite tepid economic growth? Sure enough, since Parker raised the issue last October—and predicted that US airline CEOs, having “gotten the message” regarding capacity and costs, would resist the urge to add ASMs—slow economic growth and shaky consumer confidence have persisted. Complicating the airline industry’s drive to remain profitable further is the fact that fuel costs have surged this year.

While the fuel price spike prevented US majors from improving profitability in the three months ended Sept. 30, the country’s seven largest airline companies earned $1.09 billion in combined net income in the quarter, down 45.1% from last year’s $1.98 billion profit but an impressive result given a 14.9% year-over-year rise in costs to $34 billion driven mainly by higher fuel prices. Revenue grew 9.7% to $36.5 billion and operating profit was $2.49 billion, down 29.5%.

All seven airlines were profitable on an operating basis and five of the seven earned a net profit; the exceptions were a struggling American Airlines (AA) and, owing to fuel hedging charges, Southwest Airlines (SWA). It’s not hard to see why the carriers stayed in the black: Capacity and non-fuel costs barely grew year-over-year and load factors remained extremely high.

The seven carriers’ collective third-quarter capacity lifted just 0.7% compared to the prior-year period to 238.99 billon ASMs while traffic heightened 1% to 203.41 billion RPMs, producing a load factor of 85.1%, up 0.3 points. Average yield improved 7.9% to 14.58 cents. Tellingly, CASM jumped 13.4% to 13.03 cents even as CASM excluding fuel increased only 1.5% to 7.92 cents. 

United Continental Holdings (UCH), parent of merger partners United Airlines (UA) and Continental Airlines (CO), posted a best-among-US majors third-quarter net profit of $653 million, down 23% from $852 million in pro-forma net income in the year-ago period. President and CEO Jeff Smisek vowed that the strong earnings wouldn’t drive UCH to add capacity. The company expects “sluggish economic growth in 2012” but a “stable” demand environment, he told analysts and reporters.

Though UCH will take delivery of 19 Boeing 737-900ERs and five 787s next year, it will retire aircraft (including 14 737-500s) to keep growth down, he said. Though international capacity will grow slightly next year with the addition of the Dreamliners, Smisek noted that overall “we’re effectively keeping United the same size it was [on a combined pro-forma basis] in 2010 and 8% lower on a pro-forma basis compared to 2008.” Its fourth-quarter 2011 mainline capacity is expected to be down 3.8% year-over-year.

Delta Air Lines (DL) reported net income of $549 million in the third quarter, up 51% year-over-year, on a 10% increase in revenue to $9.8 billion. CFO Hank Halter said DL is “on track to bring our nonfuel unit costs modestly above 2010 levels in the fourth quarter despite a significant reduction in capacity.” The carrier forecasted a continued lowering of system capacity including a 4%-5% year-over-year dip in the fourth quarter. “Capacity discipline” will help DL “deal with the impact of today’s high fuel prices and an uncertain economy,” president Ed Bastian said.

Alaska Airlines and Horizon Air parent Alaska Air Group (AAG) reported a third-quarter net profit of $77.5 million, down 36.7% from $122.4 million earned in the year-ago quarter. AAG chairman and CEO Bill Ayer said that “fuel prices were much higher and offset much of our revenue gains.”

US Airways’ quarterly net income declined 68.3% to $76 million from the $240 million earned in the 2010 third quarter. But Parker said the carrier was “pleased” with the result “given the 44% year-over-year increase in fuel price.” JetBlue Airways posted a third-quarter net profit of $35 million, down 40.7% year-over-year from $59 million. The LCC said that ancillary revenue continues to be a boost to earnings,
rising 7% in the third quarter compared to the prior-year period.

SWA incurred a rare quarterly net loss of $140 million in the three months ended Sept. 30, reversed from a $205 million profit in the year-ago period. The result was mostly owing to $227 million in unrealized, noncash fuel hedging mark-downs. Excluding special items, third-quarter net income was $122 million.

That was still down 37.4% from $195 million in net income on a similar basis in the 2010 third quarter. SWA noted that fuel market prices have rebounded since the Sept. 30 end of the quarter “and our future fuel hedge portfolio has gained back over $300 million in fair value.” Chairman, president and CEO Gary Kelly told analysts and reporters that the carrier’s “business is quite good” and “the revenue environment continues to be strong and stable.”

He said fuel prices are the biggest drag on earnings. “The challenges to earnings are cost-related, especially fuel costs. Were it not for that, our earnings would have been outstanding,” Kelly explained. “We saw no weakening in overall demand [in the third quarter]. And perhaps more importantly, we saw no softening in business travel.”

AA parent AMR Corp. did little to mitigate concerns about its financial health when it reported a third-quarter net loss of $162 million. The result was reversed from net income of $143 million earned in the year-ago period and marked the company’s fourth straight negative reporting period following the profit in last year’s third quarter. AA’s quarterly fuel costs soared 30% compared to last year. It is “planning for flat to down capacity next year,” CFO Bella Goren said.